Pressure on all fronts as recession looms
Financial turmoil will create significant challenges for spending, investment and taxes as Scotland moves into 2023
The market volatility witnessed in the aftermath of the last mini budget brought a rapid change of leader after just a few weeks in office. The sense of urgency around the new Government’s course of action has since helped to steady markets with many of the earlier proposals from the mini budget now ruled out. At the time of writing the Autumn Statement had been heavily trailed as one where “difficult decisions” on spending and taxes will have to be made suggesting both spending cuts and higher taxes.
This will in turn create significant challenges for spending, investment, and taxes in Scotland, with consequences for the Scottish Government’s budget on December 15. The Scottish Government has already announced a £615 million cut to this year’s budget with reduced spending and reprioritisation, much of it within the health budget, partially offsetting public sector pay increases.
It its submission to the Finance and Public Administration committee of the Parliament on the Scottish emergency budget earlier in the autumn, the Scottish Council for Development and Industry highlighted that Scotland’s ability to retain, grow and attract businesses, and retain and attract key workers, is pivotal in generating the rates of growth which will make its public finances sustainable and fund improvements in public services and spending. We proposed that working with industry to increase productivity, raise wages and attract more people to work in Scotland would be the most robust way of generating future public funds.
The energy crisis precipitated by the war in Ukraine and the post-Covid19 bounce back in many world economies continues to push up prices. The relative weakness of the pound, which helps exporters, but which pushes up the price of imported goods, has also contributed to inflation. Well-documented labour and supply chain challenges following our departure from the EU have added further pressure. The consumer prices index (CPI), excluding housing or housing related costs, rose by 11.1 per cent in the 12 months to October 2022, up from 10.1 per cent in September.
Rising housing and household services (principally from electricity, gas, and other fuels), food and non-alcoholic beverages, and transport are the largest drivers of the change in UK CPI inflation rates, which rose in October to the highest rate for 41 years. This contributed to goods inflation of 14.8 per cent in October year-on-year, well ahead of services which rose by a comparatively modest but still high 3 per cent. There were significant rises across most areas of spending although the rate of expansion eased slightly in some areas such as transport (including fuel) and communications, although these remain high by recent standards.
Continuing its bid to tackle rising prices the Bank of England’s monetary policy committee voted on November 2 to increase interest rates by 0.75 percentage points to 3 per cent, the largest hike in rates since 1989. The decision is intended to dampen demand to bring down inflation and to address concerns that a tight labour market could lead to inflation persisting longer than is desirable. The bank now expects inflation to remain high for the rest of this year, peaking in the first quarter of 2023 before falling back sharply.
Wages continue to feel the pressure as labour shortages persist
Unemployment in Scotland remains at near historic lows at 3.5 per cent broadly in line with the UK, though the figure for the three months to September represented a small rise. Nevertheless, the labour market remains tight, and this continues to impact on pay rises which continue to be outpaced by inflation.
Growth in average UK weekly earnings (seasonally adjusted total pay including bonuses and excluding arrears) reached 6 per cent in September whilst growth in regular pay on the same measure expanded by 5.7 per cent, the strongest growth in regular pay outside of the pandemic period. Analysis released by the Office for National Statistics in October of annual survey data highlighted that wages have been rising across all full-time occupations, but particularly for those in the lowest paid occupations. Hours worked remained largely unchanged (though these figures come with more than the usual health warning as they cover part of the pandemic period when work patterns were changing) but older workers over 60 saw an increase in their hours while the hours worked by younger workers (18-21 years old) decreased.
The data suggests the pressures on employers to find staff continues. Half of businesses in Scotland responding to the Fraser of Allander/Addleshaw Goddard Quarterly third quarter survey indicated they had vacancies to fill although this was down very slightly on the previous quarter suggesting a slight cooling of the labour market. Difficulties filling these vacancies persist with nine in ten firms struggling to hire the staff they need, up slightly on the last quarter, predominantly due to a lack of skills, low numbers of applications, and, increasingly, wage expectations. These shortages are starting to impact on levels of activity. In a recent British Chambers of Commerce survey, 56 per cent of businesses say they are operating below full capacity with the problem most widespread in the hospitality sector where it is just short of three in every four businesses.
Consumer confidence has dropped sharply
The cost-of-living crisis and recent economic uncertainty is also impacting on consumer confidence which fell sharply in Scotland in the third quarter (based on experimental data). We would expect this drop in sentiment to start to impact on retail sales. Scottish retail sales grew by 6.5 per cent cut on at the end of September compared to a year before, although adjusted for inflation the increase was just 0.8 per cent. UK sales growth slowed to 1.6 per cent in October. From August to October UK non-food sales fell by 1.8 per cent on last year, with higher UK food sales driven by price inflation. This has increased fears in the market about a disappointing fourth quarter, and weaker sales over the festive period. This quarterly trend continues the downwards trend in UK retail sales seen since 2021.
Contraction in output raises the risk of recession
UK gross domestic product (GDP), the most-used measure of economic activity, contracted by 0.2 per cent in the three months to September. Production output fell by 1.5 per cent and manufacturing contracted in most sectors with large drops in activity in metals and chemicals production. Flat services output masked a fall in private services including retail output, wholesale activity and personal services such as hairdressers whilst the education, transport and public services sectors were among the few areas to expand in the period.
There was a slight improvement in the UK’s trade deficit in September which, accounting for inflation, narrowed by £8.1 billion as the value of imported goods fell, in part due to falling fuel prices and a reduction in Norwegian gas imports. Exports of goods also fell but by a lesser amount and levels of imports and exports of services remained largely unchanged.
Cost pressures look set to continue to impact levels of business activity. The Fraser of Allander/Addleshaw Goddard Quarterly Monitor for Q3 noted that 85 per cent of firms expected to increase their prices by more than, or a lot more than normal, over the next 12 months and just under half of the businesses surveyed expect to reduce their operations due to higher energy prices, with the majority anticipating this reduction to be small or moderate – a 9 per cent in-crease on the previous quarter. The accommodation and food services sector had the highest share of firms (74 per cent) expecting to reduce operations due to rising energy bills. Seven in 10 firms expect economic growth to be weak or very weak, up from 65 per cent in the last quarter with just one per cent expecting strong or very strong growth.
The Bank of England now forecast a recession, which is more than six months of contraction, between the end of this year and lasting into early 2024, with unemployment likely to rise to 6.4 per cent by 2025. The respected International Monetary Fund (IMF) estimates that the UK economy will grow just 0.3 per cent for the duration of 2023, whilst the OECD expects no growth. Both put the UK towards the bottom of the table for future growth with higher-than-average inflation in the UK, with the potential for future monetary tightening that implies, cited by the IMF as one cause for concern.
The Fraser of Allander Institute expect Scotland’s economy to contract towards the end of this year leading to a recession in the first half of 2023. They anticipate Scotland will see modest growth of 0.6 per cent next year as the economy picks up in the second half, followed by a further modest 0.8 per cent expansion in 2024. There is no doubt that employers and households are bracing themselves for difficult months ahead. Uncertainty regarding the end of targeted energy relief in April, the impact of the UK and Scottish budgets on public services and the wider implications on public finances of current industrial action will all have a bearing on the public services we rely on and the economic conditions that businesses operate in.
Finding a balanced response to these pressing crises is an urgent priority, but in doing so both governments must not lose sight of the importance of investing in our future economic resilience, in skills and in the green economy to ensure a sustainable and prosperous future for Scotland.
ANNUAL LECTURE A CHANCE TO UNDERSTAND WHAT’S IN STORE IN 2023
SCDI’s annual lecture is an opportunity for senior leaders from across Scotland’s business, third and public sectors to come together to hear from a leading global expert. In 2022 we were delighted to welcome more than 400 people to the P&J Live arena for the lecture and dinner.
On February 9 2023 SCDI looks forward to welcoming Wood CEO Ken Gilmartin to give the annual lecture. Ken joined Wood after 15 years in the executive team at Jacobs and more than three decades working globally across a range of sectors. One of the world’s leading engineering and consulting companies, Wood employs over 35,000 people worldwide. Join us in Aberdeen to hear Ken’s views on the outlook for Wood and its markets in 2023 and beyond. To register for the dinner and lecture go to: eventbrite.co.uk/e/scdi-annual- lecture-tickets-441489425757